(Bloomberg) -- Billionaire Charles Koch's closely held company is cashing in on the appetite of individuals for one of the riskiest corners of the loan market.
When money manager Sound Point Capital Management recently started a new closed-end fund tied to loans, an affiliate of the Koch family bought a large portion of it. The fund, Sound Point Meridian Capital, invests in CLO equity, securities that are first in line to absorb losses on loans to leveraged companies that are packaged into collateralized loan obligations.
Institutional investors have been piling into private CLO equity funds, which provide yields that can approach 20%, thanks in part to the use of leverage. Similarly, closed-end CLO equity funds that are listed on an exchange — making them available to the public — often trade at a premium to the net value of their holdings, a sign of high demand and low supply.
Fewer than 10 of these closed-end funds trade now, partly because starting one requires a backer such as Koch that's willing to invest hundreds of millions up front and leave the money invested for years. The reward for these backers can include a share of lucrative fees the funds charge, as well as a big stake in their high-yielding shares.
CLO equity funds "are probably the highest-earning things out there outside of the BDC space," said Ryan Paylor, a portfolio manager at Thomas J. Herzfeld Advisors, referring to business development companies that lend to middle-market firms. "I'm surprised there aren't more," added Paylor, whose firm specializes in closed-end funds.
A spokesperson for Sound Point declined to comment, as did officials at Wichita, Kansas-based Koch.
The latter firm is one of the largest closely held companies in the US, generating annual revenues exceeding $125 billion through operations in oil-refining pipelines, chemicals, energy and other industries.
Private money managers form CLOs to originate or acquire leveraged loans, most of which carry high-yield ratings. After using credit lines to build a portfolio of loans, the private CLOs repay the financing by issuing several tiers of securities, including senior debt that's first to be repaid, mezzanine debt that's next in line and equity that receives the excess cash flows.
Meanwhile, closed-end funds traditionally list their shares on a stock exchange by holding an initial public offering. Investment banks generally require CLO equity funds to assemble their portfolios before taking them public, a costly process that's often a barrier to entry.
In lieu of finding capital and assembling a portfolio, some money managers convert existing closed-end funds that invest in other asset classes into CLO equity funds. Carlyle Group Inc., for example, last year took over the management of the Vertical Capital Income Fund when it switched to investing in CLO equity instead of residential mortgages and changed its name to the Carlyle Credit Income Fund.
When Sound Point Capital Management decided to create the Meridian fund, the firm, founded by Stephen Ketchum, turned to a Koch unit called Koch Financial Assets III, according to regulatory filings. Koch Financial took a stake of more than 25% in a private fund that began buying CLO equity tranches in February 2022. By the end of this year's first quarter, the private fund had acquired roughly $295 million worth of CLO equity stakes and subordinated debt.
The private fund was then folded into Sound Point Meridian when the latter held its IPO in June. Koch Financial swapped its shares in the private fund for shares in the publicly traded closed-end fund.
In addition to the Meridian stock, Koch Financial also owns between 25% and 49.9% of the closed-end fund's adviser, Sound Point Meridian Management Co., according to an investment adviser registration.
The Sound Point adviser charges an annual fee of 1.75% for managing the Meridian fund and also takes a cut of profits each quarter.
--With assistance from Scott Carpenter and Laura Benitez.
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